Look upwards: As more countries compete on cost, high-end segments beckon

The North American Free Trade Agreement (NAFTA) jumpstarted Mexico’s textiles and garments industries in 1994, when suddenly raw materials like cotton were allowed to flow freely from, and finished goods into, the US market. By 2000, Mexico had become the largest exporter of clothing to the US.

It did not hold this position for long, however. In 2001, China joined the World Trade Organisation (WTO) and soon became a magnet for foreign direct investment (FDI) in the textile industry and a newly competitive exporter. Mexico tried to protect its textile and garment industries by passing anti-dumping tariffs on Chinese clothing that were sometimes as high as 533%. But such measures did little to shield the industry: between 2000 and 2012, Mexican textile and clothing exports fell from about $9.7bn to $6bn (before rebounding to $6.4bn in 2013). As of the first quarter of 2014, Mexico was the fifth-largest exporter of clothing to the US, despite being its next-door neighbour.

Levies Lift

Mexico’s garment industry took another hit in 2011 when most of the protectionist levies expired. This forced Mexican manufacturers to compete with the Chinese in both domestic and foreign markets. However, as China’s access to the Mexican market has increased, its own industry has become less competitive. According to a report by the Centre for American Progress, a US think tank, real wages for apparel-industry workers in China increased 124% between 2001 and 2011, while those in Mexico fell 29%. Even then, Chinese wages stayed lower, at $325 a month (at purchasing power parity) compared with Mexico’s $537.

The trend in wages will continue in Mexico’s favour, but as long as such a gap persists, the country will find it hard to compete with China. Instead, the primary beneficiaries of rising wages in China’s apparel industry have been south-east Asian countries. Industry wages are 42% lower in Indonesia than in China, 28% lower in the Philippines and 22% lower in Vietnam. The textile industry in Vietnam, especially, has become an attractive target for FDI, and exports are booming.

The Snags Of Free Trade

Vietnam’s ascent explains why Mexican textile-makers eye the Trans-Pacific Partnership (TPP) warily. Twelve countries, including the US, Mexico and Vietnam, are parties to talks on the free trade agreement (FTA) which, if ratified, would create a tariff-free zone around the Pacific rim. The prospect of Vietnam gaining preferential access to markets in Mexico and the US, its main trading partner, is making Mexican firms uneasy. “The TPP could very much harm the textile and garment industries in Mexico, if the yarn forward criteria are not established for determining the origin of textile goods,” Martín Urrutia, executive president of Santiago Textil in Mexico City, told OBG. “China is losing its textile leadership because of price increases and quality issues. Even though wages are still higher in Mexico, we have important logistical advantages. Vietnam is emerging as a dangerous player globally, with China-like prices but better quality these days.”

Mexican textile firms are watching the negotiations especially closely. All eyes are on the TPP’s rules of origin, which establish the percentage of content in a finished good that must originate in a country that is party to an FTA for that good to be eligible for preferential treatment under that FTA. These rules can be onerous and impose inefficiencies on industry by forcing manufacturers to eschew cheaper inputs in favour of locally produced ones. They can even cause manufacturers to bypass FTAs altogether: they may prefer simply to pay normal tariffs to avoid supply chain restrictions.

Mexican companies and industry associations (and their counterparts in the US) are therefore advocating for a “yarn forward” rule of origin, which would require that all inputs in a finished garment or textile be sourced from a TPP country. Such a rule would prevent manufacturers in Vietnam from using low-cost Chinese textiles to make garments in factories employing their own (cheaper) labour. Mexican and American industries fear that, if Vietnamese factories are allowed to do this, the North American market will be flooded with Asian goods even cheaper than those already available. This would be a boon to consumers but a debilitating blow to North American textile manufacturers.

Challenges

The industry faces different challenges at home. One is that electricity costs in Mexico are inflated by government surcharges, a condition particularly damaging to textile plants, which are big energy consumers. The energy reform passed in 2013 (and to be implemented with secondary legislation in 2014) is expected to lower the cost of power by eliminating these surcharges and opening up Mexico’s energy market to private investment, thus boosting competition.

Another challenge is contraband. Truckloads of illegal textile goods enter Mexico each year, skewing prices. Smugglers can often skirt Customs duties by understating their value, by mislabelling them (as goods that are subject to lower tariffs), or by misrepresenting their origin (as being from countries with which Mexico has FTAs). Rosendo Valles Costas, general manager of Convertex, a textile supplier in Mexico City, told OBG, “60% of money spent on clothing in Mexico is spent on contraband.” Mexican industry believes much of these goods come from China and that the Chinese government turns a blind eye. In 2012, Mexico filed a dispute against China with the WTO, alleging that its subsidisation of the textile industry violated WTO rules. The US later joined the dispute, which is still in consultations.

Nichification

To meet these challenges, Mexican manufacturers have sought upmarket niches that have less price-sensitivity. In some of these segments, they have met with success, such as men’s wool suits, name-brand undergarments, non-woven fabrics for medical applications, and upscale jeans.

In this last segment, Mexico has a strong edge. To produce non-basic jeans – for brands like Seven for all Mankind, Levi’s and True Religion, all of which import from Mexico – requires more added-value work, such as special washes and ornamentation. Mexican companies’ long history producing jeans means foreign clothing companies have confidence in their workers’ proficiency. Furthermore, proximity to the US is a more important advantage for name-brand jeans and other “high-design” garments than it is for basics. Designer garments are sold in lower volume and more often in cycles, so shorter response times are crucial.

Mexico became the number-one exporter of men’s and boy’s jeans to the US after its share of this segment grew about 10% a year between 2008 and 2012. Today, Mexico’s exports of jeans are well over $2bn.

On The Horizon

The future of Mexico’s textiles and garments industry lies in pursuing niches, like high-end jeans, for which Mexico’s specific advantages are relevant. This would involve a pivot towards low-volume, high-margin goods that are less price-sensitive and benefit more from short lead times. Competing on cost with the likes of Vietnam will not be feasible much longer: Mexican industry is still finding its way after being swiftly eclipsed by low-cost, Asian manufacturing. It may never reclaim the position it once held as one of the most competitive places for large-scale manufacturing at rock-bottom costs, but the possibility exists for a reinvention as a higher added value industry.